2014 Summary State of SME Finance in the United States

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1 White Paper 2014 Summary State of SME Finance in the United States Aseem Grover and Kati Suominen* January 2014 * Aseem Grover is MBA Candidate at the UCLA Anderson School of Management; Kati Suominen is Founder and CEO of TradeUp Capital Fund. TradeUp, January

2 Executive Summary Small and medium-sized enterprises (SMEs), firms with fewer than 500 employees, are the backbone of U.S. economy. They make up 99 percent of all firms, employ over 50 percent of private sector employees, and generate 65 percent of net new private sector jobs. SMEs account for over half of U.S. non-farm GDP, and represent 98 percent of all U.S. exporters and 34 percent of U.S. export revenue. To thrive, SMEs need access to credit and cash flow. Credit conditions for U.S. SMEs deteriorated in the wake of the financial crisis, and are expected to continue depressed as Basel III capital adequacy requirements come into effect in Early-stage companies seeking equity finance have also faced challenges, as venture capital is increasingly focused on laterstage companies and available only to a handful of firms. What is the state of SME finance in the United States today, five years after the financial crisis? This TradeUp white paper provides answers. We review trends in lending and equity financing to SMEs, discuss emerging financing sources for SMEs, and assess the future of SME finance in light of the rise of alternative, online lenders and crowdfunding. We will also analyze the specific financing issues faced by SMEs that seek growth through exports. The summary highlights of this report are as follows: Overall, financing for SMEs appears to be recovering from the immediate post-recession years. However, the more traditional sources of SME capital banks for loans and VCs for early-stage funding are focusing on larger and less nascent companies. A number of instances and new delivery methods are taking their place, from online micro- and small business lenders to supply chains finance programs, angel investors, and crowdfunding platforms. Bank lending to SMEs has improved, but has yet to return to pre-crisis levels. In June 2013, the loan balances for commercial and industrial (C&I) loans of $1 million or less stood at $288.7 billion, $47 billion below June Federal government sources have played a complementary and to an extent countercyclical role during the past few years in SME lending. In FY 2013, SBA supported $29.6 billion in lending to small businesses, about the levels of the prior two years. The Export-Import Bank supported export credit insurances and export working capital for SMEs at $5.2 billion in 2013, somewhat below authorizations. The burgeoning market of online lenders has yet to be analyzed fully, but the success of several platforms indicates a new, strong, and relatively affordable source for financing particularly for small firms that lack access to sufficient bank credit. Expansion-sand Late-stage investments together accounted for $13.4 billion of VC investments through Q1-Q3 of Seed- and Early-Stage investments attracted 46 TradeUp, January

3 percent less investments during the same time period amounting to a total of $7.2 billion. The Software industry continues to garner the most VC dollars in the United States, while Silicon Valley continues to dominate the US VC investments by geography, leading the pack with 42 percent investments in Internationally, Israel and United States remain the hotbeds of innovation with the highest VC spending as a percent of GDP among the OECD countries in Angel investment is recovering and has become a strong complement to VC financing. In the first two quarters of 2013, angels invested a total of $9.7 billion, an increase of 5.2 percent over the first half of 2012 and 5 percent increase form Global crowdfunding volume nearly doubled in 2012 to $2.7 billion, of which over onehalf, or $1.6 billion, was in North America. Crowdfunding is expected to exceed $5 billion in As the U.S. economy recovers, 2014 appears to become a big year for alternative lenders and investors on the online and crowdfunding spaces, and see their expansion also to mobile platforms. However, bank financing to SMEs is expected to continue subdued as Basel III capital adequacy requirements come into effect in Because banks will have to hold additional cash in reserve to meet the terms of Basel III, they will have less money to lend compared to pre-crisis levels, which is expected to have a disproportionately negative effect on SME financing opportunities. This however will open up opportunities for new business models to accommodate the recovering financing demands by American SMEs. TradeUp, January

4 2014 Summary State of SME Finance in the United States Introduction Small and medium-sized enterprises (SMEs), firms with fewer than 500 employees, are the backbone of U.S. economy and employment. They make up 99 percent of all firms, employ over 50 percent of private sector employees, and generate 65 percent of net new private sector jobs. America s 28 million SMEs account for over half of U.S. non-farm GDP. SMEs are also more inclined to export than are large firms. While U.S. SMEs export participation is quite limited compared to other advanced nations, with 5 percent of all SMEs engaging in exports, SME exporters represent 98 percent of all U.S. exporters and 34 percent of U.S. export revenue. To grow and contribute to the U.S. economy and exports, SMEs need access to free cash flow and credit. Indeed, financing is widely found to be the single most robust determinant of firm growth. 1 However, small firms consistently report higher financing hurdles than large enterprises given their small size, limited assets, and general inability to raise funds through credit markets or publicly traded equity. 2 Given that SMEs tend to have greater volatility in earnings and growth than do larger companies, they are seen as riskier investments, and thus subject to higher cost of capital. 3 In addition, with limited staff and time, SMEs have high opportunity costs to cultivate relationships with lenders, or to diversify these relationships so as to shop around for the best deal. Credit conditions for U.S. SMEs deteriorated in the wake of the financial crisis, and are expected to continue depressed as regulatory environment tightens and as Basel III capital adequacy requirements enter into effect in Because banks will have to hold additional cash in reserve to meet the terms of Basel III, they will have less money to lend compared to pre-crisis levels. These new standards are expected to have a disproportionately negative effect on SME financing opportunities. Early-stage companies seeking equity finance have also faced challenges. Venture capital is increasingly focused on later-stage companies and available only to a handful of firms. Yet at the same time, angel investors have assumed a greater role in start-up capital, and crowdfunding is poised to add significantly to, if not transform, start-up finance. The purpose of this annual update is to take stock of SME finance in the United States by reviewing trends in lending and equity financing to SMEs in , discuss emerging financing sources for SMEs, and assess the future of SME finance in light of Basel III and other regulatory changes. We will also analyze the specific financing issues faced by SMEs that seek growth through exports. The first section reviews of importance of capital for SMEs and for SME exporters. Section two assesses lending to SMEs in the past several years, highlighting two newer trends, the rise of online lending platforms and supply chains finance. Section three focuses on venture capital transactions. Section four turns to angel investment, and section five discusses the rise of crowdfunding. Section six concludes. TradeUp, January

5 1. Importance of Capital to SMEs Growth and Trade Financing is widely seen as the key driver of SMEs growth and exports alike. Capital is the oxygen that enables the firm to market their goods and services, expand production capacity, and sustain cash flow. At the same time, SMEs are widely viewed as having more limited access to capital than large companies. Given their typically higher volatility and less extensive financial track record, SMEs are generally more credit-constrained than are large firms. SMEs tend to have fewer external financing sources available to them and are typically much more dependent on banks than are larger firms, which can raise capital through such measures as issuance of bonds, commercial paper, or publicly traded equity. Further, it takes typically as much work, if not more, for lenders to assess the creditworthiness of a small borrower as a large one, particularly as smaller firms tend to have less financial history and fewer formal financial tracking processes. These relatively high processing costs are reflected in the financing costs on SMEs. In addition, with limited staff and time, SMEs have high opportunity costs to cultivate relationships with lenders, or to diversify these relationships so as to shop around for the best deal. In a rigorous global study on access to capital that covers 10,000 firms from 80 countries, including the United States, the probability that a small firm lists financing as a major obstacle is 39 percent compared with 36 percent for medium-size firms and 32 percent for large firms. 4 Recent surveys reflect the central place of capital for SMEs work and the challenges in accessing financing. When asked to name the most severe obstacles to growth in a recent survey by Federal Reserve Board of New York, 49 percent of 670 surveyed SMEs (of up to 499 employees) listed access to capital as the leading challenge (figure 1). No other challenge such as taxes, finding employees, or regulations, was as widely cited. Unsurprisingly, access to capital varies with the firm s performance: 66 percent of SMEs operating at a loss listed access to capital as a growth challenge, whereas only 36 percent of profitable SMEs cited access to capital as a challenge to future growth. The external funding obstacles reflected in the main sources of financing for SMEs are not bank loans or external funding, but business earnings, personal savings, and credit cards (figure 2). The most typical need is to secure cash flow and fund day-to-day operations (cited as the reason for seeking financing among 40 percent of respondents, followed by inventory (12 percent) and plan, equipment, and vehicle investment (10 percent). These results are echoed in the online lender OnDeck s October 2013 survey, where access to credit was cited as the top concern among small businesses, ahead of such challenges as growing sales and taxes. They are also similar to international survey results: in a World Bank survey, SMEs across emerging markets and developing countries listed lack of financing as the second most severe obstacle (after corruption), while large firms placed it fourth. 5 TradeUp, January

6 Figure 1 Growth Challenges among U.S. SMEs, 2013 Source: FRBNY Small Business Credit Survey, May 2013 (N=670) Figure 2 Primary Funding Sources for U.S. SMEs, 2013 Source: FRBNY Small Business Credit Survey, May 2013 (N=650) TradeUp, January

7 1.1 Capital is Critical also for SME Exporters U.S. SMEs are seeking growth through exports in record numbers. There is enormous latent capacity just in the United States: only 300,000 of U.S. SMEs export. Recent surveys indicate that three-quarters of current SME exporters and a near-quarter of non-exporters look to expand their exports. For these SMEs, access to capital is key for setting up and expanding export-related operations, offering competitive payment terms to foreign customers, developing new export products and markets, and investing in production facilities, new capabilities and staff required for exporting. Indeed, export activities generate additional financial needs for which exporting SMEs need to identify and source capital: Export entry involves high upfront sunk costs stemming from such activities as identifying foreign customers and new export markets, creating distributor networks, and meeting foreign product standards. These costs are proportionally much greater for SMEs than they are for large firms. Prospective born global companies are particularly disadvantaged, despite their exceptional potential for innovation and growth, as they have limited assets available as collateral, and as equity financing is often available only for a select number of firms. Costs of each export transaction can be more onerous than those incurred in the domestic market, such as higher shipping, logistics, and trade compliance costs. As an example, cross-border shipping and delivery usually take days longer to complete than do domestic orders, with each day in transit adding to shipping costs. 6 In addition, exporters need sufficient resources to manage risks such as potential customer non-payment, exchange rate instability, and cash flow problems. Exporters need sufficient cushion and resources to manage risks such as potential customer non-payment and exchange rate instability all the while having to accommodate foreign buyers, such as large foreign OEMs (original equipment manufacturers) that demand payment terms that extend beyond the 60- and 90-day norm in the U.S. market. Recent academic literature finds that firms that are credit constrained are less likely to export. 7 Conversely, access to finance enhances firm s exports and buoys SMEs exports in particular. 8 In addition, exporting loosens firms credit constraint, for example by making companies more productive and by playing a countercyclical role when domestic markets flail. 9 Survey data show that inadequate financing constrains trade especially among SMEs, as they tend to be more credit-constrained than large companies. In a 2010 U.S. International Trade Commission survey of 2,349 SMEs and 849 large firms, 32 percent of SMEs in manufacturing sectors and 46 percent of SMEs in services sectors cited obtaining financing as burdensome to conducting cross-border trade. By contrast, only 10 percent of large manufacturing firms and 17 percent of large services firms shared this view. 10 What is more, out of 19 hurdles, SME manufacturers rated access to financing as the steepest hurdle to trade, while SMEs in service sectors rated access to capital as the third hurdle to trade (figures 3-4). 11 TradeUp, January

8 These data are echoed by surveys in other advanced markets. In a 2008 OECD survey of 230 SMEs, access to working capital was ranked as the greatest hurdle to trade, out of 47 hurdles. 12 In a 2010 survey commissioned by the European Commission of nearly 9,500 European SMEs, 54 percent of SMEs viewed lack of capital as an important barrier to doing business in the EU market and 44 percent to doing business in extra-eu markets. No other barrier (paperwork, laws and regulations, lack of information on overseas markets, etc.) was considered as important. Figure 3 - U.S. Manufacturing SMEs Cite Obtaining Financing as the Leading Impediment to Engaging in Global Trade Source: U.S. International Trade Commission (2010). Figure 4 - U.S. Services SMEs View Obtaining Financing as the Third Leading Impediment to Engaging in Global Trade Source: U.S. International Trade Commission (2010). TradeUp, January

9 2. Lending to SMEs: Alternative Sources Filling the Gap The financing challenges faced by SMEs were compounded by the financial crisis, which severely undermined SMEs credit conditions. Bank lending to SMEs has improved, but has yet to return to pre-crisis levels. In June 2013, the loan balances for commercial and industrial (C&I) loans of $1 million or less stood at $288.7 billion, $47 billion below June 2008 preceding the Great Recession (figure 5). The annual decline in small-business lending in has reversed, yet particularly the smallest of SMEs have trouble securing a loan, and loans are not as substantive as they used to be. The total number of small business loans has been increasing from levels (figure 6), however the average loan size is still below 2010 levels. Some of the causes behind the lowered lending are bank consolidation, which has reduced the number of banks focused on the small business segment; and increased regulatory scrutiny that has caused banks to tighten lending standards and secure more internal approvals, which in turn has reduced the share of creditworthy borrowers and also increased bank s fixed costs per loan, making SME loans less attractive. 13 Recent research on the heightened supervision during and after the recession finds that increased stringency can have a statistically significant impact on total loans and loan capacity for some 20 quarters after the onset of the tighter supervisory standards. 14 Granted, banks are not the only bottleneck: small businesses have also been borrowing less in the past few years lackluster economy, as weak earnings and economic uncertainty have translated into subdued loan demand. 15 In addition, collateral values have been low as real estate prices have declined, curtailing the amount that small business owners can borrow. In a Wells Fargo/Gallup quarterly survey of 600 small business owners with up to $20 million in annual sales, the share of percentage of small business owners intending to increase capital investment over the next 12 months fell between 2007 and 2013, from a high of 33 percent in Q2 of 2007 to 20 percent Q and 24 percent in Q4 of The share of small business members of the National Federation of Independent Businesses (NFIB) who said they borrowed once in the past three months fell from 36 percent to 29 percent between January 2008 and June 2012, and was at steady 30 percent in December Frustrated by long processing times at credit unions, small business customers are gradually going back to bigger national and regional banks for their financing needs. In 2012, the most prolific U.S. SME lenders include American Express, First Citizen Bancshares and Wintrust Financial (appendix I). Larger players such as Citizens, TD Bank, Union Bank, and Wells Fargo are becoming increasingly active in small business lending. Yet approvals are hard to secure, in part because small business financials have been weak. According to the November 2013 Biz2Credit Small Business Lending Index, the largest banks with over $10 billion in assets approved only 17.4 percent of loan applications. Smaller, community banks are granting about half of the loan applications. TradeUp, January

10 Figure 5 - Loans to Small Businesses by FDIC-Insured Institutions in , by Loan Size Source: FDIC. Figure 6 - Loans to Small Businesses by FDIC-Insured Institutions in , by Number of Loans in Loan Size Category Source: FDIC. TradeUp, January

11 2.1 Small Business Administration Loans SBA has played somewhat of a countercyclical role as bank lending to small business has dried up. In FY 2013, SBA supported $29.6 billion in lending to small businesses, nearly at par with SBA s two record years of supporting $30.25 billion in small business loans in FY 2011 and $30.5 in FY 2012 (figure 7). In total, the SBA supported 54,106 loans in Among others, this included 7, loans (totaling $11.7 billion), which provide small businesses with long-term, fixed-rate financing to acquire real estate and major fixed assets; 682 CAPlines loans at $500 million that provide working capital lines of credit to meet small businesses short-term working capital needs; and 4,000 Small Loan Advantage (SLA) loans ($625 million) that are under $350,000 loans targeting small businesses and entrepreneurs in underserved communities. Figure 7 SBA-Supported Loans to Small Businesses in (7(a) and 504 loans in millions of $, microloans in actual number) Source: SBA Annual Report for FY Export-Import Bank Guarantees and Instruments The U.S. Export-Import Bank (Ex-Im) supports small business export transactions by offering export credit insurance, working capital guarantees, and direct loans, particularly to SMEs foreign customers. In 2013, Ex-Im authorized a record 3,413 small business transactions, of which the bulk, or 83.4 percent, were export credit insurances rather than working capital loan guarantees (figure 8). Ex-Im authorizations supported $5.2 billion in small business loans, of which 54 percent went towards export credit insurance and 35 percent towards working capital loan guarantees (figure 9). Overall, in dollar terms, Ex-Im s small business portfolio is about a fifth of the total, even though small business transactions consistently make up over 80 percent of transactions (figure 10). Ex-Im transactions overall support only a small share of U.S. exports, typically 1-2 percent. TradeUp, January

12 Figure 8 Number of Ex-Im Bank-Supported Export-Related Loan Authorizations to Small Businesses in Source: Ex-Im Bank annual reports, Figure 9 $ Value of Ex-Im Bank-Supported Export-Related Loan Authorizations to Small Businesses in Source: ExIm Bank annual reports, TradeUp, January

13 Figure 10 ExIm Bank-Supported Export-Related Loan Authorizations to Small Businesses in as % of all Authorizations Source: ExIm Bank annual reports, Perceptions of Loan Availability The perceptions of small businesses and banks on availability of loans differ somewhat. In June 2012, the Federal Reserve Board of Governors asked loan officers to describe their current loan standards using the range between the tightest and easiest that lending standards at your bank have been between 2005 and the present. 17 For non-syndicated loans to small firms with annual sales of less than $50 million, 39.3 percent said that standards were tighter than the midpoint of the range, while only 23 percent said they were easier than the midpoint of the range. However, banks have recently viewed the lending conditions as having improved in the past two years (figures 11-13). TradeUp, January

14 Figure 11 - Net Percentage of Domestic Respondents Tightening Standards for C&I Loans, Source: Federal Reserve Board. Figure 12 - Net Percentage of Domestic Respondents Increasing Spreads of Loan Rates over Banks' Cost of Funds Source: Federal Reserve Board. TradeUp, January

15 Figure 13 - Net Percentage of Domestic Respondents Reporting Stronger Demand for C&I Loans Source: Federal Reserve Board. On the SME side, the majority still consider it harder to secure loans (figure 14) which may also help explain the recent years subdued borrowing. However, the ratio of those considering it easier to secure loans to those seeing it harder is shrinking. At the end of 2013, a net of 7 percent of small businesses saw the availability of loans as reduced, in contrast to some 15 percent in early A similar trend occurs in the Wells Fargo/Gallup Small Business Index: in Q4 of 2013, 27 percent of small businesses stated that obtaining credit in the past 12 months had been very difficult or somewhat difficult, significantly down from 37 percent in Q1 of 2012, but still higher than 13 percent at the start of 2008 (figure 15). For export-driven companies, these trends are compounded by a profound lack of understanding of financial instruments and government programs aimed at exporters. In a 2013 survey by the National Small Business Association (NSBA), as many as 82 percent of small businesses already engaged in exporting reported that their lending institution never discussed U.S. Export-Import Bank products with them, and some 22 percent had never even heard of the Ex-Im Bank. 18 Only 12 percent reported using an Ex-Im product to help finance their export activities, and just 5 percent had used Ex-Im financing through a commercial bank. In addition, a mere 3 percent had made use of SBA s export lending programs. TradeUp, January

16 Figure 14 SMEs Perceived Availability of Loans Net Percent ( Easier Minus Harder ) Compared to Three Months Ago Source: NFIB Small Business Economic Trends Monthly Report, January Figure 15 SMEs Perceived Difficulty of Obtaining Credit in the Past 12 Months Source: Wells Fargo and Gallup Small Business Survey Topline Quarter 4, 2013 (margin of error ± 4 percentage points). TradeUp, January

17 2.4 Remaking SME Finance: Rise of Online Nonbank Lenders As traditional sources of small business credit have dried up, SMEs have turned to alternative sources, first and foremost online to technology-enabled financing platforms that have proliferated in the past few years. These platforms offer speed and higher odds of success than traditional lenders, approving an estimated two-thirds of the loan applications they receive within minutes or a few days. They also typically use a wider or a different set of criteria than do traditional lenders to assess the borrower s credit worthiness, such as analyzing the business owners credit card payment records. In exchange for the speed and convenience, borrowers typically pay a premium in the form of higher interest rates. Select, high-growth online platforms for small business loans include such direct loan providers as OnDeck that offers small business loans of up to $250,000 across industries, and intermediaries such as Biz2Credit and Boefly that match small businesses to lenders across the nation. There are non-profit models, such as microlender Accion. An additional source of financing for small business is peer-to-peer lending platform such as LendingTree or Lending Club, which target individuals instead of business borrowers. Small businesses have reportedly used these platforms for small loans (typically up to $35,000 or so) to fund expansion or pay off debt. Some peer-to-peer lenders, such as Dealstruck, have focused solely on the small business market offering loans of $50, ,000 for up to 3 year terms with interest rates of 5-15 percent. Granted, all of these lenders require the businesses to meet certain criteria, such as cash flow, profitability, certain amount of time in business, and so on. In addition to these platforms offering a variety of financing instruments for an array of businesses, there are specialized providers serving a defined clientele. For example, in the fall of 2013, Paypal started extending small business working capital loans to its merchants, and Google also reportedly has plans to lend to small businesses. There are also new accounts receivable companies extending financing against domestic and foreign receivables, and merchant cash advance companies, such as Kabbage. New lending players such as Lighter Capital focuses on high-growth software and tech firms, offering royalty-based loans that accommodate fluctuations in the company s cash flows. Non-bank online lending accentuated in late-2013 during the government shutdown, which not only brought SBA-backed lending to a halt, but also undercut non-sba lending as the IRS was closed and not verifying borrowers revenue figures. A notable longer-term trend favoring online platforms is the growth in the number of entrepreneurs using mobile to apply for funding which is something that the non-traditional lending platforms are better-equipped to accommodate than are traditional lenders. Credit unions in particular have yet to embrace online let alone mobile platforms, and are as a result argued to lose countless opportunities. Table 1 provides an illustrative list of various lenders and their focus. In addition to these has also been loan-based crowdfunding platforms; these will be discussed below. TradeUp, January

18 Table 1 Illustrative List of Online Non-Bank SME Lenders Provider Instruments Amounts Term OnDeck Biz2Credit Boefly Accion Loans - direct Array of loans, lines of credit, and other instruments - loan request will be matched to the lending criteria of our network of over 1,200+ lenders Loans - loan request will be matched to the lending criteria of our network of over 3,600+ lenders Microloans $5,000 - $250,000 $5,000 - $1 million Varies Up to $50, months (average 6-9 months) Interest rate 15% (avg) Daily Varies Varies Varies Varies Up to 60 months Platform user fee $249 (minimum) %, closing costs 5%, $135 application fee Payment Sectors Website Varies Varies Over 700 different industries, including restaurants, retailers and other service providers Various sectors and segments (women, veterans, etc.) Typically franchisors Established and emerging businesses; start-ups; businesses in food, beverage, hospitality industries https://www.on deck.com/ 2credit.com/ fly.com/ ionusa.org/ Dealstruck Peer-to-peer loans $50,000- $250,000 Up to 3 years 5-15% Varies Several: manufacturing, services, wholesale, retail https://www.de alstruck.com Kabbage Paypal Lighter Capital Accounts Receivable Financing Cash advance to buy inventory, equal monthly transfers Working capital loans Royalty-based loans Accounts receivable financing, including overseas $500- $50,000 Max. 8 percent of merchant's annual receipts, up to $20,000 $25,000- $500,000, or percent of company's annualize d runrate N/A Flexible 1-5 years N/A 2-10% in the first 2 months, 1% thereafter Set fee as a deduction of 10-30% of incoming receipts until paid - estimated as 4-12% interest Percent of monthly top-line revenue; up to 25% 1-3% per month Monthly Based on receipts Monthly Monthly Various Paypal merchants (90,000 firms) Software, technology and knowledgebased companies Various https://www.ka bbage.com/ https://www.pa ypal.com/weba pps/workingca pital/tour htercapital.com / ountsreceivable financing.com/ TradeUp, January

19 2.5 Boosting SMEs Cash Flow: Rise of Supply Chain Finance Supply Chain Finance (SCF) has existed for a long time. However, the credit constraints in the wake of the financial crisis have made SCF increasingly attractive option for financing SME suppliers in corporate value chain, as a means to enhance suppliers cash flow. SCF is typically initiated by a large corporate buyer to reduce supplier risk. Large buyers increasingly want better terms, such as a longer payment cycle, from their supplier. Yet meanwhile these suppliers need to be paid so as to purchase new supplies and cover business expenses. Typically, the SMEs make up for the gap in cash flow by borrowing against their accounts receivable. However, the terms involved in this arrangement can be very taxing on the supplier s financial viability which in turn poses a supplier risk to the buyer. In order to preserve the supplier s financial health, the buyer helps the SME supplier access more affordable credit through a bank, or offers a sophisticated corporate solution that optimizes payments among many participants in the supply chain. Using SCF, the corporate buyer is able to pay SME suppliers faster, thus helping the SMEs improve cash-flow and secure financing at lower cost. This in turn fuels the SMEs operations, making them more stable and reliable and thereby reducing the large buyer s supplier risk. The set-up is a win-win-win: buyers get terms extensions, suppliers liquidity, and banks access to short-term commercial trade-related transactions. According to several estimates, only a fraction of the need for global supply chain finance has as yet been met. New firms have sprouted to specifically address this gap, such as PrimeRevenue, which provides multi-bank supply chain finance, and Tradeshift, which enables businesses that have invoiced a large enterprise to immediately access the money they are owed once the buyer has confirmed its intention to pay. Several governments, including U.S. government, have established supply chain finance initiatives in order to incentivize uptake by corporate buyers and banks. Some initiatives are explicitly related to exporters and indirect exporters. For example, in 2011, the U.S. Export-Import Bank approved a $740 million program to offer guarantees for up to 90 percent of that capacity to support Boeing s U.S. suppliers (that are also indirect U.S. exporters and hence supported by Ex-Im Bank). 19 The initiative forms part of Ex-Im Bank s Supply-Chain Finance Guarantee Program, which enables suppliers to receive early payment of their accounts receivable that are due from participating exporters, such as Boeing, Caterpillar, and Case Holland in exchange for a small discount fee that is paid to the lender. Ex-Im Bank provides a 90 percent guarantee of the invoices while the lender (Citibank for Boeing suppliers) bears 10 percent of the risk. In the UK, the government reached an agreement in September 2013 with three dozen corporations such as Rolls-Royce, Vodafone, and General Dynamics UK to boost supply chain finance. The bank is notified by a large company that an invoice has been approved for payment; the bank is then able to offer a 100 percent immediate advance to the supplier at lower interest rates, knowing the invoice will ultimately be paid by the large company. TradeUp, January

20 3. For Venture Capital, Bigger Is Better The dot-com bubble of late 1990s saw venture capital spending in the United States reach its peak in 2000 with total spending of more than $105 billion across 8,000 deals. 20 After the dotcom crash of 2000, the venture capital industry struggled to raise new funds, resulting in decreased VC funding of $19 billion in VC funding increased at a compounded annual growth rate of 13 percent until 2007, when the financial crisis and the ensuing economic downturn stalled this growth in its track. Since 2009, the overall venture capital funding in the United States has remained at a relatively steady level, and is reportedly picking up on the back of declined investor interest in emerging markets Stage of Development The breakdown of venture capital investments by stage of development of has changed over the last twelve years. Funding at the seed level continues to be smallest proportion of venture capital funding in the United States (figure 15). Expansion-stage funding, which was the recipient of the biggest proportion of VC investments has seen its share of total funding decline over the years. Early and Later stage funding has steadily extracted bigger chunk of the total VC pie. Figure 15 U.S. Venture Funding by Stage of Development Source: Money Tree report from PwC and NVCA. Seed-stage investments that once touched $3.2bn during the peak of the dot-com bubble have seen ups and downs over the last decade. While funding for seed stage investment improved as the economy recovered during , it has seen a gradual decline since the financial turmoil, resulting in total number of deals in seed funding declining from 536 in 2008 to 143 at the end of TradeUp, January

21 Q3 in 2013 (figure 16). Per the Money Tree report from PwC and NVCA, the average Seed deal up until Q3 in 2013 was $3.5 million, up 21 percent from Q3 of Early-stage dollar investments rose in 2011 to their highest level ($8.9 billion) since the dot-com crash. This upward trend was visible in 2012, which saw the highest number of early stage deals invested in by U.S. venture capitalists. In Q1-3 of 2013, early-stage deals received $6.8 billion. The average early-stage deal up until Q3 in 2013 was $4.7 million, down 4.9 percent from Q3 of Figure 16 - U.S. Venture Capital Seed / Early Stage Funding Source: Money Tree report from PwC and NVCA. Expansion-stage investments attracted the biggest piece of the pie in 2000, have decreased since then and been at relatively steady levels since 2010 (figure 17). Overall, Expansion stage dollar investments accounted for 32 percent of all venture investments in 2012, up 1.2 percent from the previous year. The average expansion stage deal was $9.8 million in Q3 2013, identical to the average expansion stage deal in VC investments in later-stage deals have decreased almost 72 percent since In 2012, 22 percent of all venture deals were attributed to later-stage deals. The average later-stage deal was $11.5 million in Q3 2013, up 9.7 percent from Q TradeUp, January

22 Figure 17 U.S. Venture Capital Later / Expansion Stage Funding Source: Money Tree report from PwC and NVCA. 3.2 Industry Analysis High-Tech Due to the less capital intensive nature of the business, the Software industry has traditionally captured the highest VC dollars among the high-tech industries. The Software industry received the largest investment in 2012 with $8.6 billion going into 1,369 deals, representing a 109 percent increase in dollars and 65 percent increase in deals since 2009 (figure 18). The biotechnology industry received the second highest VC dollars in 2013 but the overall VC dollars have stayed relatively flat declining only 3 percent since The medical device industry has received the third largest investment from venture capitalists since 2005 peaking in 2007 with $2.7 billion. The semiconductor industry has declined the most since the dot-com crash, recovering briefly before tumbling again in A number of factors including uncertain global economy, ongoing inventory overhang, and a shift from PCs to mobile devices caused a downward trend for the semiconductor industry. The 2013 year-to-date (Q3) VC dollars invested declined 27 percent when compared with the first three quarters from TradeUp, January

23 Figure 18 U.S. High Tech Venture Capital Funding Source: Money Tree report from PwC and NVCA. Non-High Tech Venture capital investment in non-high tech industries has traditionally been lower when compared with the high tech industry. The media and entertainment industry VC funding, which reached its lowest point in 2003, has recovered steadily since then increasing at a 13 percent compounded annual growth rate from (figure 19). The energy and industrial sector which peaked in 2008 with dollar investments $4.6 billion declines 37 percent from 2008 to 2012 and continues decline in 2013 with only 165 deals closed by the end of third quarter. The Consumer Products and Services sector has attracted the third largest share of investment since From a low of $157 million in VC dollar investments in 2003, VC investments increased at a compounded annual growth rate of 27 percent to $1.3 billion in TradeUp, January

24 Figure 19 U.S. Non-High Tech Venture Capital Funding Source: Money Tree report from PwC and NVCA. Business Products and Services, Retailing and Distribution, and Healthcare services have seen the most declines over the last decade. The Business Products and Services industry had its highest share of VC investments since the dot-com crash in 2006, but has declined 74 percent in year-to-date (Q3) dollar investments in 2013 when compared with the same time period in The healthcare services sector saw robust growth in VC investments after the Affordable Care Act was announced in VC investments have since declined 34 percent in dollar investments and 19 percent in deals year-over-year during the first three quarters of Region VC dollars invested in the United States continue to be dominated by Silicon Valley. The proportion of dollars being invested in Silicon Valley has increased from 32 percent in 2000 to 42 percent today (figure 20). While a distant second, New England region continues to hold steady, with 11 percent of VC dollars invested in 2013 flowing through to this region. The New York Metro region comes in a close third and has held steady attracting 8-10 percent dollars invested over the last decade. VC investment in the southern California region of LA and Orange County VC has been relatively flat at approximately 6 percent since the dot-com bubble era. Interestingly, the southeastern region of United States that accounted for almost 8 percent VC investment in 2000, today attracts only 4 percent of the total dollars invested in the United States. TradeUp, January

25 Figure 20 - Proportion of Amount Invested by Region Source: Money Tree report from PwC and NVCA. 3.4 Venture Capital Spending Comparison: U.S. vs. Other OECD Countries Venture capital investments, representing the riskiest ownership in an entity, has accounted for a very small fraction of the GDP for most countries. Among the OECD countries, Israel and United States represented the highest VC spending as a percentage of GDP in 2012 (figure 21). Notably, the two countries differ in VC spending split between early and late stage companies. While early stage companies attracted 84 percent of total VC spending in Israel, only 32 percent of VC spending in the United States went towards early stage firms. TradeUp, January

26 Figure 21 - Venture Capital Investments as % of GDP 2012 Source: OECD Entrepreneurship at a Glance The harsh effects of the financial crisis of 2008 on VC spending were felt strongly by the OECD countries. According to OECD data, VC spending in most countries remains significantly below the 2007 levels (figure 22). Portugal and Spain, the two European countries embroiled in the European debt crisis continue to attract the least amount of VC dollars spent in The United States VC spending grew 19.7 percent from 2009 to However, this amount was still 16.4 percent lower than the 2007 level. Ireland, Luxembourg, and South Africa were the only three OECD countries in 2012 to exceed the VC spending levels of TradeUp, January

27 Figure 22 - Trends in Venture Capital Investments Source: OECD Entrepreneurship at a Glance Angels: Reaching a Par with VCs As venture capital has moved to bigger deals, angels have filled the gap for startups. Angel market has also recovered steadily since In the first two quarters of 2013, periods for which data are available through the Center for Venture Research at the University of New Hampshire, the angel investor market showed signs that a sustainable growth. Angels invested a total of $9.7 billion, an increase of 5.2 percent over the first half of 2012 and 5 percent increase from 2007 (figure 23). A total of 28,590 ventures received angel funding in the first half of 2013, a 4.8 percent increase from the first half of 2012, and the number of active investors was 134,895 individuals, up by 2.9 percent from the first half of 2012 (figure 24). The increase in total dollars and the matching increase in total investments resulted in an average deal size of $337,850. Much like VCs, angels too have migrated somewhat away from seed and start-up stage investing. In the first half of 2013, only 38 percent of angel investments went in the seed and start-up stage companies. This is positive for companies starting out, but also significantly below the pre-2008 peak of 55 percent, with angels having moved toward expansion and growth capital financings, and positioning their investments for growth in Still a relatively limited number of ventures received angel backing. In the first half of 2013, the share of deals that angels invested in of all deals brought to angels was 21.5 percent, an increase from the first half of 2012 (17.8 percent) and comparable to 2012 (21.3 percent) (figure 25). TradeUp, January

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